LONDON, Sept 28 (Reuters) - The euro fell to an eleven-day low on Friday after Italy’s government agreed a budget overnight seen by some investors as defying Brussels.

Political wrangling over the budget in heavily indebted Italy has put a lid on a recent revival in the euro’s fortunes against the dollar.

The single currency recorded its biggest one-day decline in seven weeks on Thursday as the battle over fiscal policy intensified in the euro zone’s third largest economy.

Financial markets are nervous that the Italian government’s spending plans will boost Italy’s debt, which is already the second highest in the euro zone as a share of economic output after Greece, at around 131 percent of gross domestic product.

The government is targeting a budget deficit at 2.4 percent of gross domestic product, inside the 3.0 percent ceiling prescribed by EU rules.

Some traders were caught off guard by the euro’s abrupt move.

“It does come as a surprise that the euro exchange rates suddenly react in such a pronounced manner to fiscal factors,” said Ulrich Leuchtmann, FX strategist at Commerzbank in Frankfurt.

“But market participants are now hoping for a normalisation of ECB interest rates... and that is why the euro is generally still quite strong,” he said.

European Central Bank chief Mario Draghi said this week he sees a vigorous pickup in euro zone inflation.

Despite a widening in Italian swap spreads, the Italian budget debate remains a “headwind, rather than an active drag, on the single currency,” said ING currency strategist Viraj Patel.

The euro on Friday fell 0.2 percent to $1.1615 after slumping almost 0.9 percent overnight. Versus the Swiss franc it traded at 1.1347, near a one month low of 1.1415

The dollar meanwhile remained buoyant.

It advanced against the British pound and the franc and rose to a nine-month high versus the Japanese yen after data reinforced upbeat views about the U.S. economy and a recent Fed hike.

“The broad rally by the dollar has also been helped by seasonal factors, as it has coincided with U.S. investors bringing funds back home for the month’s end,” said Yukio Ishizuki, senior forex strategist at Daiwa Securities in Tokyo.

Markets will now turn to euro zone preliminary inflation data due later in the day to see if they can support ECB President Draghi’s views on prices. The annual inflation rate is expected to rise to 2.1 percent, according to a Reuters poll.

The pound was little changed at $1.3068 after falling 0.7 percent overnight.

The Swiss franc was near a one-month low of 0.9782 per dollar brushed overnight, when it tumbled more than 1 percent.

The Australian dollar edged up 0.15 percent to $0.7216 after shedding 0.7 percent on Thursday. (Additional reporting by Shinichi Saoshiro in Tokyo Editing by Peter Graff)